ASSET-LIABILITY MANAGEMENT SYSTEM. ALM. Presented by c.s.balakrishnan. WHY ALM?. Globalisation of financial markets. Deregulation of Interest Rates. Multi-currency Balance Sheet. Prevalance of Basis Risk and Embedded Option Risk.
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ASSET-LIABILITY MANAGEMENT SYSTEM ALM Presented by c.s.balakrishnan
WHY ALM? • Globalisation of financial markets. • Deregulation of Interest Rates. • Multi-currency Balance Sheet. • Prevalance of Basis Risk and Embedded Option Risk. • Integration of Markets – Money Market, Forex Market, Government Securities Market. • Narrowing NII / NIM.
ALM • ALM is the process involving decision making about the composition of assets and liabilities including off balance sheet items of the bank / FI and conducting the risk assessment.
ASSET LIABILITY MANAGEMENT • Various risks affecting banks / FIs • Credit, Market, Operational • Deregulation & competition • Need to manage risk to protect NIM • Need for proper risk mgt policy • Liquidity planning, interest rate risk management • ALM guidelines issued for banks in Feb 1999 and for FIs in Dec 1999
Concept of ALM • ALM is concerned with strategic management of Balance Sheet by giving due weightage to market risks viz. Liquidity Risk, Interest Rate Risk & Currency Risk. • ALM function involves planning, directing, controlling the flow, level, mix, cost and yield of funds of the bank • ALM builds up Assets and Liabilities of the bank based on the concept of Net Interest Income (NII) or Net Interest Margin (NIM).
WHAT IS ALM • ALM is concerned with strategic Balance Sheet management involving all market risks • It involves in managing both sides of balance sheet to minimise market risk
ALM Objectives • Liquidity Risk Management. • Interest Rate Risk Management. • Currency Risks Management. • Profit Planning and Growth Projection.
LIQUIDITY RISK • What is liquidity risk? • Liquidity risk refers to the risk that the institution might not be able to generate sufficient cash flow to meet its financial obligations EFFECTS OF LIQUIDITY CRUNCH • Risk to bank’s earnings • Reputational risk • Contagion effect • Liquidity crisis can lead to runs on institutions • Bank / FI failures affect economy
LIQUIDITY RISK • Factors affecting liquidity risk • Over extension of credit • High level of NPAs • Poor asset quality • Mismanagement • Non recognition of embedded option risk • Reliance on a few wholesale depositors • Large undrawn loan commitments • Lack of appropriate liquidity policy & contingent plan
LIQUIDITY RISK • Tackling the liquidity problem • A sound liquidity policy • Funding strategies • Contingency funding strategies • Liquidity planning under alternate scenarios • Measurement of mismatches through gap statements
LIQUIDITY RISK • METHODOLOGIES FOR MEASUREMENT • Liquidity index • Peer group comparison • Gap between sources and uses • Maturity ladder construction
LIQUIDITY RISK • RBI GUIDELINES • Structural liquidity statement • Dynamic liquidity statement • Board / ALCO • ALM Information System • ALM organisation • ALM process (Risk Mgt process) • Mismatch limits in the gap statement • Assumptions / Behavioural study
ALM SYSTEM • Liquidity Gap report – fortnightly • 1-14 d & 15 – 28 d – tolerance limit • Fix cumulative gap limits • IRS statements – monthly • Fix prudential limits • To compile currency wise liquidity and IRS reports
MATURITY PROFILE-LIQUIDITY • Outflows • Capital, Reserves & Surplus • Deposits • Borrowings and bonds • Other liabilities
MATURITY PROFILE-LIQUIDITY • Inflows • Cash • Balance with RBI • Balance with other banks • Investments • Advances
IRR - Relevance in India • Deregulation of interest rates brought: • Volatility in rates - call, PLR, Govt. securities Yield Curve • Competition - free pricing of assets and liabilities • Pressure on NII / NIM, MVE
RSA, RSL • RSA (Rate Sensitive Assets) – Assets whose value is dependent on current interest rate • RSL (Rate Sensitive Liabilities) – Liabilities whose value is dependent on current interest rate
Gap/Mismatch Risk • It arises on account of holding rate sensitive assets and liabilities with different principal amounts, maturity/repricing rates • Even though maturity dates are same, if there is a mismatch between amount of assets and liabilities it causes interest rate risk and affects NII
ALM ORGANISATION Three-tier organizational set-up for ALM Implementation : • Management Committee of the Board (MC) • Oversees the ALM implementation by ALCO • Reviews the ALM implementation periodically • Funding strategies for correcting the mismatches in ALM Statements.
ASSET-LIABILITY MANAGEMENT COMMITTEE (ALCO) - ALCO headed by E.D. - GM (T) – (Nodal Officer). - GMs : Central Accounts, P&D, Credit, Risk Management International Division are the members. - GM (IT) & AGM (Economist) are the invitees for ALCO meetings.
FUNCTIONS OF ALCO Implementation of ALM System • Monitor the risk levels of the Bank. • Articulate the Interest Rate Position & fix interest rate on Deposits & Advances. • Fix differential rate of interest rate on Bulk Deposits. • Facilitating and coordinating to put in place the ALM System in the Bank.
ALM STATEMENTS TO BE SUBMITTED TO RBI • Statement of Structural Liquidity (Annexure - I) [DSB Statement No.8] - Rupee • Statement of Interest Rate Sensitivity (Annexure - II) [DSB Statement No. 9] - Rupee • Statement of Dynamic Liquidity (Annexure - III) • Statement of Maturity and Position (MAP) (Annexure - IV) [DSB Statement No.10 ] - Forex • Statement of Sensitivity to Interest Rate (SIR)(Annexure - V)[DSB Statement No.11] - Forex
Tools for ALM System • Gap Analysis • Modified Gap Analysis • Duration Gap Analysis • Value at Risk (VaR) • Simulation
LIQUIDITY RISKS • Broadly of three types: • Funding Risk: Due to withdrawal/non-renewal of deposits • Time Risk: Non-receipt of inflows on account of assets(loan installments) • Call Risk: contingent liabilities & new demand for loans • Dynamic liquidity is done to measure the liquidity risks
STATEMENT OF STRUCTURAL LIQUIDITY • Placed all cash inflows and outflows in the maturity ladder as per residual maturity • Maturing Liability: cash outflow • Maturing Assets : Cash Inflow • Classified in to 8 time buckets • Mismatches in the first two buckets not to exceed 20% of outflows • Banks can fix higher tolerance level for other maturity buckets.
ADDRESSING TO MISMATCHES • Mismatches can be positive or negative • Positive Mismatch: M.A.>M.L. and vice-versa for Negative Mismatch • In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc. • For –ve mismatch,it can be financed from market borrowings(call/Term),Bills rediscounting,repos & deployment of foreign currency converted into rupee.
DYNAMIC LIQUIDITY • Prepared every fortnight for ALCO • Projection is given for the next three months • Tools for assessing the day to day liquidity needs of the bank
STATEMENT OF INTEREST RATE SENSITIVITY • Generated by grouping RSA,RSL & OFF-Balance sheet items in to various (8)time buckets. • Positive gap : Beneficial in case of rising interest rate • Negative gap: Beneficial in case of declining interest rate
CALCULATION OF NII/NIM • NII: INT.EARNED-INT. EXPENDED • INT. EARNED: ADV+INVEST+BALANCE WITH RBI • INT. EXPENDED:DEPOSITS+INT. ON RBI BORROWINGS • NIM= (NII/TOT.EARNING ASSET)X100
SUCCESS OF ALM IN BANKS :PRE - CONDITIONS • Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams. • Method of reporting data from Branches/ other Departments. (Strong MIS). • Computerization - Full computerization, networking. • Insight into the banking operations, economic forecasting, computerization, investment, credit. 5. Linking up ALM to future Risk Management Strategies.